Public Funds Investment Institute

Is Crypto in Our Future?

May 30, 2024
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Crypto is slowly making its way into the consciousness of mainstream investors, including those who invest public funds. One indication is the passage last week by the House of Representatives of FIT21 (the Financial Innovation and Technology for the 21st Century Act), though it is unlikely to become law in this Congress. Another is a (reluctant?) move by the Securities and Exchange Commission to approve trading for a Bitcoin exchange traded product . And, though it may be mostly for show, the announcement by a presidential campaign that it would take crypto donations is yet another.

Away from these Washington events it is not clear why or what purpose crypto might serve those investors in the mainstream. In some ways it seems to be a solution in search of a problem. 

That said, it is out there so it is worth a few comments:

  • Crypto is a product of blockchain technology. Some would say it is a creative (or cynical?) way to create/extract value from a bunch of boring computer algorithms. (If you want a quick study there is a good introductory primer on crypto and blockchain technology by PWC here.)  Blockchain, or distributed ledger accounting, may have some potential in the financial markets. Arguably, it could address risk elements of centralized ledgers and reduce the time it takes to move money and securities. For example, if there were perceived or identified risks in the operation or accounting at such institutions as the Federal Reserve, the DTCC, and the major custody banks blockchain might be a substitute.  But are these problematic? And arguably distributed ledgers are not without their own set of risks. As to speed of money movement and securities settlement, existing technology (including the new FedNow program) could be fast enough. (Ever wonder why some folks buy cars that can do 150 miles an hour when most highways cannot support, or don’t permit, speeds at anything like this rate?)
  • Is cryptocurrency money? Money is a medium of exchange for things (a loaf of bread, a medical service) that usually is backed by something of value (gold) or the fiat of a government with authority (“A dollar is worth a dollar because I say it is”). Some crypto coins like Tether are backed by something of value like dollars, but if you are going to rely on dollars ultimately to transfer value, why complicate things by trading in something that “represents” the underlying asset? Perhaps because you do not want to account for or transfer the asset through a transparent and regulated system like a bank. But why is that? The most common answers to this question are not good answers.
  • What is crypto worth? You would expect a medium of exchange to have a known value. If a public agency takes in $100 in tax revenue, it is certain to be worth $100 when it is spent on goods (paving material) or services (teacher salaries). Not so for cryptocurrency. As the Federal Reserve observed in a policy statement on crypto issued last year   “ in the absence of a fundamental economic use case, the value of most crypto-assets is driven largely by sentiment and future expectations, and not by cash flows from providing goods or services outside the crypto-asset ecosystem.”
  •  Cryptocurrency is not legal tender in the US. So says the IRS in a 2023 Notice. Rather, it is property. A farmer might take property (20% of the wheat harvested on a field) in return for doing the harvesting. A public agency might take property in payment of taxes or tolls or use property to pay its obligations, but if you think about it this way it raises issues about value/fungibility and storage/transfer that are different for the farmer than for the governmental unit. Anyway, blockchain technology addresses the latter (crypto is stored in a distributed ledger system) but not the former issue.
  • Crypto operates outside of the bank payment system.  So, for the most part, when crypto is accepted in exchange for goods or services it is immediately converted by the merchant into a fiat currency at the then-prevailing rate so that it can pass into and through the banking system. While there are advocates for permitting banks to deal in crypto the Federal Reserve Board is adamantly opposed. In its 2023 Notice it observed that “issuing tokens on open, public, and/or decentralized networks, or similar systems is highly likely to be inconsistent with safe and sound banking practices .The Board believes such tokens raise concerns related to operational, cybersecurity, and run risks, and may also present significant illicit finance risks, because—depending on their design—such tokens could circulate continuously, quickly, pseudonymously, and indefinitely among parties unknown to the issuing bank.”
  • Crypto could be a great investment. Or not. For government units its valuation and return characteristics would seem to be at odds with the key characteristics of other investments that make up public funds portfolios—safety and liquidity.  It might produce triple digit investment returns from time to time, but so might other investments that are not a part of a public funds portfolio.

The bottom line. Payment system or investment? Public agencies might want to accept crypto in payment of obligations to accommodate taxpayers, though they should recognize that crypto has an economic cost to hold/convert just as do other commodities (and some would argue it has a social cost by encouraging Illicit activities).  Investing in crypto, or seeking authority to do so, seems hard to square with the widely accepted investment objectives for public money that prioritize safety and liquidity over yield (or return).

Greetings, fellow colleagues in the public funds investment community! I'm Marty Margolis, a seasoned expert with a deep understanding of the intricacies of managing public sector investments. Having led the growth of PFM Asset Management and managing assets exceeding $150 billion, I am excited to connect with you through the Public Funds Investment Institute. If you haven't already — subscribe below to join our community, explore our thought leadership, and gain valuable insights. I encourage you to connect with me on LinkedIn or reach out via email to share your thoughts, feedback, and ideas. Let's collaborate and make a positive impact together.

Best regards,
Marty Margolis

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